Topic 6 - Accounting for Trusts Flashcards
Relevant Property Trusts
What charges and taxes apply to RPTs?
What trusts are not RPTs?
CGT and IHT of a trust depends on if it is a RPT.
Created on/after 22 March 2006. Mostly discretionary trusts but other trusts can be used. Some exceptions.
The following are not RPTs:
- Absolute (Bare) Trust - because beneficiary has absolute right to trust’s capital and income.
- Transitional serial interest trust - where interest under a pre-march 2006 Interest in possession trust was changed before 6 October 2008.
- Immediate post-death interest trust – Interest-in-possession trust created with immediate effect under the terms of a will.
- Other exceptions are a trust for a disabled person; a trust for a bereaved minor and an age 18–25 trust.
Transfers into a RPT chargeaable lifetime transfers and subject to 20% over NRB within previous 7 years.
Also subject to periodic and exit charges during life of trust.
Income and gains recieve by RPTs treated as belonging to trustees rather than beneficiary and special rules apply.
How are non-relevant property trusts taxed and charged?
Tranfsers out of relevant property regime treated as normal gifts for iHT so no lifetime charge applies and will be out of estate after 7 years.
Income and CGT regarded as benificiaries and they pay tax not the trust.
Discretionary Trust Taxation
How is income and CGT charged in a discretionary trust?
How are transfers into a discretionary trust treated for IHT and what are the associated charges?
Treated a RTPs. Charegeable lifetime transfers.
Lifetime charge and periodic and exit charge if exceeds NRB.
Income and CGT treated as trustees at special rates
Income -
- standard rate band of £1,000
- 7.5% on dividends
- 20% on other income
- above £1,000+
- 38.1% on dividends
- 45% on interest
- Not eligible for personal savings and dividend allowances
- Beneficiary can claim tax credit of up to 45% if they should have paid less tax than the trust on reccieved income.
Capital Gains -
Annual exemption of 50% of standard exemption £6k
Excess then 20% or 28% for property
Interest in Posession Trust
Chargeable lifetime transfers for IHT.
At least one state beneficiar as immddiate and automatic right to income after
One or more stated beneficiaries of an interest-in-possession trust has an immediate and automatic right to income received by the trust fund (after trust expenses); the trustees have no discretion regarding payments.
The trustees are liable for the basic-rate of tax applicable to each source of income received by the trust: 7.5% on dividends or 20% on non-dividend income. The trustees do not have a personal allowance and are not eligible for the personal savings and dividend allowances. The net income is paid to the income beneficiary (usually a life tenant) who will be assessed for tax on the income as if it was paid gross. The beneficiary will receive a tax credit for any income tax deducted in the trust, which can be reclaimed if the tax was overpaid, or will be credited towards the total due if the beneficiary was a higher- or additional-rate taxpayer.
The trustees have a CGT annual exemption of £6,000 – half the standard exemption available to individuals. Gains in excess of the exemption are taxed at the higher rates of 28% for property and 20% for other asset
What the legal obligations of trustees to HMRC with regards to tax?
Trustees must advise HMRC:
- Full title
- Details of trust
- Settlor and trustees
- Assets
- Created on lifetime or death
- Trust and estate self-assessmnet tax return. Deadline 31 Jan following tax year end (online). (October 31st if paper). £100 penalty for late submission.
Exception is a bare trust where beneficiary will complete tax returns and inform HMRC, allbeit with less detail.
- Tax return payments for income due 31 Jan and 31 July with balancing payment following 31 Jan.
- Tax return payments for CGT due 31 Jan after tax year of gains.
- Interest charged on unpaid tax. Penatly £100 for late payments, and after 30 days onward regular interval penatlies until paid.
What are the CGT implications when transferring assets into a trust?
CGT on Death
No CGT on gains made on assets in estate. Liability dies with them as IHT applies. Assets are revalued at tome of death when transferred to beneficiary or trust and deemed to have then acquired them at that value for CGT.
CGT on Lifetime Transfer
Lifetime transfer into trust is disposal for CGT at point of transfer and settlor may be liabile.
May be possible to claim hold-over relief for certain business assets and agricultural property or transfers into interest-in-possession trusts and all other discretionary trusts.
Hold Over Relief - Transferor does not pay tax and gain is transferred with assets. Not available for transfer into a bare trust or any trust where settlor, their spouse or minor children may benefit so must be specifically excluded from trust’s potential beneficiaries.
Transfers into a public purpose trust will normally be exempt from CGT.
What are the possible IHT implications of transferring into a trust?
PETs
Transfers into non relevant property trusts - bare trust, vulnerable persons trust etc is NOT CLT - no immediate tax liability and will only form part of iHT if settlor dies within 7 years of transfer. If transfer exceeds NRB then excess will be PET.
CLTs
Transfers into discretionary, interest in poessesion (after 22 March 2006 - as now relevant property settlement) trust is CLT.
If cumulative total of transfers over 7 years exceeds NRB then immediate 20% charge on amount above NRB payable by trustees.
Public Charity Trust
Gifts made by individuals (lifetime or upon death) to public purpose trusts are exempt from IHT
Example 1
Petra, who has made no other gifts in recent years, transfers £400,000 on 4 August 2018 into a discretionary trust.
She will be able to use two years’ worth of IHT exemptions, so the chargeable amount will be £394,000.
There will be an immediate tax liability of £13,800 (£394,000 – £325,000 = £69,000 x 20%). This can be seen as a non-refundable deposit on the final amount of IHT payable when the settlor dies and is deducted from the final liability. However, if the final bill is less than the 20% lifetime charge, no refund can be claimed.
If Petra were to live beyond 4 August 2025, there would be no more tax to pay as she had lived for seven years after making the gift, but the original £13,800 would not be reclaimable.
If Petra were to die in December 2020 (assuming the NRB was still £325,000), then a further 20% tax (ie £13,800) would become payable from her estate because she died before taper relief came into play. However, were she to live more than three years, but less than seven, taper relief would apply, and the NRB may increase. The ‘deposit’ (lifetime charge) is deducted from the final IHT liability.
Example 2
Petra dies in November 2023, five years and three months after making the gift. The taper relief rules mean that 40% of the IHT charge would apply to the gift. In this case, the full charge is calculated on the original gift:
Full IHT on the chargeable gift £394,000 – £325,000 x 40% = £27,600.
Then we apply taper relief: £27,600 x 40% = £11,040 IHT due.
Then we deduct the lifetime charge paid on gifting. In this case, the £13,800 lifetime charge was more than the final bill, so no further payment is required, but there is no refund of the £2,760 ‘overpaid’.
Of course, in this example, the trust does not actually receive £400,000. It receives £386,200 (£400,000 – £13,800) net of tax.
Supposing Petra wishes to ensure that the trust receives £400,000. She needs to gross up the lifetime charge by 20%.
The calculation is £13,800 / 0.8 = £17,250, so the gift should be £417,250.
£417,250 – £6,000 = £411,250 gift.
£411,250 – £325,000 = £86,250 x 20% = £17,250, leaving a net gift of £400,000.
What is the 14 year rule, how does it work and how should gifts be ordered to take full advantage?
If a PET fails because donor does not live for 7 years, necessary to check if any CLTs in previous 7 years have been made as a CLT made 13 years and 364 days ago could be included in equation.
First calculate IHT on failed PET (payable by the recipient of PET):
- Add all CLTs made in seven years before PET
- Add the result to the failed PET
- Deduce NRB from this figure
- Apply 40% IHT to excess over NRB, applying any aper relief
Then calculate IHT payable on the estate, using the following steps:
- Reduce estate’s NRB by amount of PET. Residence NRB will also apply if property is left to direct descendant. Estate NRB is not reduced by the CLT if it was made more than seven years before death.
- Aply 40% IHT to result of step 1 which is payable by estate.
Example 1
George, who is divorced, made the following gifts during his lifetime:
1 September 2010 – gift of £225,000 to a discretionary trust (a CLT). This was the net amount after two years’ worth of annual gift exemptions. No tax at the time as it was below the NRB.
1 March 2017 – gift of £250,000 (a PET) to his daughter Karen. This was the net amount after two years’ worth of annual gift exemptions. No tax at the time as it was below the NRB.
George died on 20 November 2019, leaving an estate of £650,000 to Karen.
The failed PET
Steps 1 and 2 – The PET failed, as the gift occurred within seven years of death. The CLT would be added to the PET as it was made within seven years of the PET:£250,000 + £225,000 = £475,000.
Step 3 – £475,000 – £325,000 = £150,000 taxable as the failed PET.
Step 4 – £150,000 taxable at 40%. IHT on the failed PET £60,000, payable by Karen. No taper relief as the PET was made within three years of death.
IHT on the estate
Step 1 – PET deducted from the NRB. £325,000 – £250,000 = £75,000. The CLT does not affect the estate NRB because it was made more than seven years before death.
Step 2 – £650,000 – £75,000 = £575,000 taxable estate at 40% = £230,000 IHT payable by the estate.
Example 2
Annie, who was single, made the following gifts during her lifetime:
1 September 2008 – gift of £150,000 to a discretionary trust (a CLT) for her nephews. This was the net amount after two years’ worth of annual gift exemptions.
1 July 2014 – gift of £225,000 (a PET) to her sister, Alice. This was the net amount after two years’ worth of annual gift exemptions.
Annie died on 20 September 2019, leaving an estate of £400,000.
The failed PET
Steps 1 and 2 – the PET failed, as the gift occurred within seven years of death. The CLT would be added to the PET as it was made within seven years of the PET: £225,000 + £150,000 = £375,000.
Step 3 – £375,000 – £325,000 = £50,000 taxable.
Step 4 – £50,000 x 40% = £20,000 IHT. Taper relief reduces the IHT by 60% (death between five and six years of the gift). IHT on failed PET = £8,000, payable by Alice.
IHT on the estate
Step 1 – PET deducted from the NRB. £325,000 – £225,000 = £100,000 NRB.
Step 2 – £400,000 – £100,000 NRB = £300,000 taxable estate x 40% = £120,000 IHT, payable by the estate.
If gifting order is reversed, and a PET is made followed by a CLT then a PET would only be taken into account if made within seven years of death so 14 year rule does not apply.
However if PET is made within 7 years of death and followed by a CLT the amount of failed PET is deducted from NRB available to trustees when calculation periodic charges on trust.
What is the general order that should be followed for transferring assets into trust and why?
Relevant propert trusts - Trustees liable to further IHT charges every 10 years and when money leaves trust - up to 6% of trust assets above the NRB.
In general, the order in which gifts should be made is
- exempt gifts
- chargeable lifetime transfers
- potentially exempt transfers
Because 10 year periodic charge on trust will depedn on other CLT were made in 7 years before trust was set up. If client made a PET in period before trust was set up then died within 7 years, the failed PET is included in trust’s tax calculation, even if it didn’t benefit from the PET.
If, however, the PET is made after the CLT, it will not be included in the calculation even if it fails.
Can trusts be used to reduce the value of an estate, if so which ones?
Trusts don’t normally reduce estate but prevents IHT on future growth of assets. Exceptions are:
Discounted Gift Trust
Gift and Loan Trust
Discounted Gift Trust
Explain how a discounted gift trust works, the key factors in them and how they are taxed?
What are some chargeable events under a discounted gift trust?
Immediate reduction in estate through gifting into a trust and securing regular income.
Trust set up, Settlor gifts cash to trustees who set up bond. Or settlor sets up bond and transfers ownership of bond to trustees.
Discount is higher for younger people. Not suitable for those very old or in poor health due to lower chance of surviving seven years.
Initial gift is a PET if to absolute trust so remains in estate for seven years. Or CGT if into discretionary trust meaning immediate 20% lifetime charge if over NRB. Growth outside estate.
Settlor is then paid agreed annual income for remainder of life. Payments taken from beneficiaries’ part. If death occurs earlier then beneficiaries recieve balance of settlor’s rights with no IHT.
Settlor must spend income or it will be absorbed back into their estate so should be used to make gifts but income from bond cannot be used to justify gifts as normal expenditure but can make from other sources and rely on bond income.
Income is fixed for life but could potentially
- defer
- escalate (5% average)
- waive income (added as gift to trust)
Neither the settlor nor their spouse/civil partner should be a life assured, which means that their death will not result in payment of the bond death benefit. It is important that the bond is set up on a second death basis with at least two lives assured, at least one of whom should be younger than the settlor and likely to outlive them, because the bond death benefit will be paid when the youngest life assured dies, and the bond will end at that point. Income payments stop when the death benefit is paid, which is why it is important to ensure that the lives assured are likely to outlive the settlor.
Chargeable events
- Excess withdrawals
- death of a life assured, why important to select younger lives assured;
- surrender of bond by trustees.
Gift and Loan Trust
What is a gift and loan trust
How does a gift and loan trust work?
What are some other important considerations?
- Designed to use investment to reduce IHT.
- Settlor sets up absolute or discretionary trust with small gift - from £10 or annual exemption £3k.
- Makes further payment into trust as interest-free loan. As a loan it is not a transfer.
- Trustees use gift and loan to arrange investment bonds, on lives of settlor and beneficiaries but owned by trustees.
- Repayable on demand. Growth on bond remains out of estate, original capital stays in until repaid.
- Can withdraw 5% per year. Trustees use as partial repayment of loan.
- Settlor must spend income payments recieved or will remain inside estate.
- After 20 years loan has been repaid and original capital is outside of estate.
- Death before loan is repaid will mean outstanding loan included in estate unless another life has been assured in which case it will continue.
Other Considerations
Bond must be set up after trust has been set up as trustees must purchase bond and not normally possible to use existing bonds.
Trust should include settlor exclusion clause to show no benefit other than repayment of loan.
How are shares and securities valued for IHT?
How are unit trusts and OEICs valued for IHT?
Assets in estate valued for IHT at open market price on da of transfer.
Quoted shares/securities
The Stock Exchange Daily Official List (SEDOL) - Closing bit and offer prices. IHT takes lower of:
- Quarter-up basis - If range from £10.80 to £11.00 then quarter of difference is 5p. So £10.85.
- Average of highest and lowest marked bargains for day.
- If stock market closed on day then can choose day before or after*.
- Cum dividend - includes value of right to next dividend. If ex-dividend then add whole of future dividend. Clean price - [(periods copuon) x (days/days in period)].*
For example, if an individual owned £1,000 of Treasury stock with a coupon of 10% (payable half-yearly) quoted at a price of £103−£104 ex-interest, then the next interest payment would be £50 (£1,000 x 10% x 6 months / 12 months).
The quarter-up valuation for IHT would be £1,072.50:
£1,032.50 (quarter up) + £40 (£50 less 20% tax).
Unit trusts/OEICs
Managers bid or selling price.
Describe the tax position with regard to CGT when a transfer is made to a public (charitable) purpose trust.
A transfer into a public purpose trust is usually exempt from CGT
A lifetime transfer into what types of trust will be classed as a potentially exempt transfer?
A lifetime transfer into a bare or vulnerable person’s (certain disabled persons or bereaved minors) trust will be classed as a potentially exempt transfer. In addition, a lifetime transfer made before 22 March 2006 into an interest-in-possession trust is also classed as a potentially exempt transfer.
